The surtax for any amount of net income not shown in the above table is computed by adding to the total surtax for the largest amount shown which is less than the income, the surtax upon the excess over that amount at the rate indicated in the table. For example, if the amount of net income is $63,128, the surtax is the sum of $8,690 (the surtax upon $62,000 as shown by the table) plus 30 per cent of $1,128, or $338.40, making a total surtax of $9,028.40.14

COMPUTING THE TAX-ILLUSTRATION. The tax on a married person with a net income of $15,000 for the year 1919, assuming that none of such income consists of (a) dividends from a corporation taxable for income tax purposes on its net income, or a personal service corporation out of earnings or profits subject to income tax, or (b) interest upon obligations of the United States or bonds issued by the War Finance Corporation, is computed as follows:

The tax on an unmarried person would be increased by 8% on $1,000 or $80, since the personal exemption is $1,000 less, and the balance of taxable net income over $4,000 would be increased accordingly. In case a married person or the head of a family is entitled to further exemption because of persons dependent upon him, the normal tax will be reduced at the rate of $16 for each such dependent, that is, 8% on $200.15

Husband and Wife. Where a husband and wife make returns of their joint incomes, neither the normal tax nor surtax is to be computed on the joint income of both, but on the separate income of each although the incomes of both may be reported in the same return.16

Surtax on Stockholders in Respect of Undistributed Profits of Corporations. The surtax is ordinarily assessed only upon income actually received by the taxpayer. But if any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its stockholders or members through the medium of permitting its gains and profits to accumulate, instead of being divided or distributed, the corporation is not subject to income tax, and the stockholders are taxable as stockholders of a personal service corporation, except that the excess-profits tax paid by the corporation will be deducted from its net income before the computation of the proportionate share of each stockholder or member.17 This provision applies only where the accumulation is permitted for the purpose of avoiding the surtax. Ordinarily, the stockholder of a corporation has no need to concern himself with or to make any inquiry as to the undistributed income of the corporation.18 The fact that a corporation is a mere holding company, or that the gains and profits are permitted to accumulate beyond the reasonable needs of the business is prima facie evidence of a purpose

15 Revenue Act of 1918, § 216 (d).

16 Revenue Act of 1918, § 216 (c); Reg. 45, Art. 2; T. D. 2090; T. D. 2137. 17 Revenue Act of 1918, § 220. This provision is broader than the provision contained in the 1916 Law, which authorized the Commissioner to assess a tax on the shareholders with respect to the undistributed profits only in cases where such profits were allowed to accumulate with fraudulent intent to avoid the surtax. Compare the section with section 3 of the Revenue Act of 1916. The taxation of personal service corporations is discussed in Chapter 9.

18 See T. D. 2135.

to escape the surtax. The collectors, however, have no authority to decide when gains and profits are accumulated beyond the reasonable needs of the business so as to be taxable as indicated above. The Commissioner must first certify that in his opinion the accumulation is unreasonable.19 In any case the Commissioner or a collector may require a corporation to furnish a statement of its gains and profits and of the names, addresses, and shareholdings of the stockholders, and if upon the basis of such statement or other evidence the Commissioner certifies that in his opinion its accumulation of profits is unreasonable for the purposes of the business, the corporation and its stockholders must make their returns accordingly.20 When the Commissioner has so certified, the stockholders are notified and called upon to add the amount of their respective shares in the undistributed gains and profits of the corporation for the year to their income from other sources and to pay the surtax accordingly.

PURPOSE TO ESCAPE SURTAX. The application of the rule stated in the foregoing paragraph depends upon the two elements of (a) purpose to escape the surtax and (b) unreasonable accumulation of gains and profits. Prima facie evidence of (a) exists where a corporation has practically no business except holding stocks, securities or other property and collecting the income therefrom, or where a corporation other than a mere holding company permits its gains and profits to accumulate beyond the reasonable needs of the business. The business of a corporation is not limited to that which it has previously carried on, but in general includes any line of business which it may legitimately undertake. However, a radical change of business when a considerable surplus has been accumulated may afford evidence of a purpose to escape the surtax. When one corporation owns the stock of another corporation in the same or a related line of business and in effect operates the other corporation, the business of the latter may be considered in substance the business of the first corporation. Gains and profits of the first corporation put into the second through the purchase of stock or otherwise may therefore, if a subsidiary relationship is established, constitute employment of the income in its own business. To establish that the

19 Revenue Act of 1918, § 220.

20 Reg. 45, Art. 351.

business of one corporation can be regarded as including the business of another it is ordinarily essential that the first corporation own substantially all of the stock of the second. Investment by a corporation of its income in stock and securities of another corporation is not of itself to be regarded as employment of the income in its business.21

UNREASONABLE ACCUMULATION OF PROFITS. An accumulation of gains and profits is unreasonable if it is not required for the purposes of the business, considering all the circumstances of the case. No attempt can be made to enumerate all the ways in which gains and profits of a corporation may be accumulated for the reasonable needs of the business. Undistributed income is properly accumulated if invested in increased inventories or additions to plant reasonably needed by the business. It is properly accumulated if retained for working capital required by the business or in accordance with contract obligations placed to the credit of a sinking fund for the purpose of retiring bonds issued by the corporation. In the case of a banking institution the business of which is to receive and loan money, using capital, surplus and deposits for that purpose, undistributed income actually represented by loans or reasonably retained for future loans is not accumulated beyond the reasonable needs of the business. The nature of the investment of gains and profits is immaterial if they are not in fact needed in the business.22

21 Reg. 45, Art. 352. 22 Reg. 45, Art. 353.

CHAPTER 3

INDIVIDUALS TO WHOM THE LAW IS APPLICABLE

The theory upon which the income tax is imposed seems to be two-fold. The law imposes the tax upon the net income of all persons within its jurisdiction, regardless of the source of such income, and upon all income arising from sources within the United States, regardless of whether or not the United States has jurisdiction of the recipient. The tax has been defined as a tax on the person, measured by his ability to pay, that is, his net income,1 and as a tax on the income itself. As a matter of fact, it is both. The Government claims personal jurisdiction over all

1 In Brady v. Anderson, 240 Fed. 665, writ of certiorari denied, 244 U. S. 564, the court said: "In our opinion the tax is against the citizens and residents of the United States personally. They are chargeable in respect to income received by them." In State ex rel. Moon Co. against Wisconsin Tax Commission (Wis.) 163 N. W. 673, the Court said: "Much confusion of thought arises from regarding the income tax as a tax that is levied upon or attaches to property as such, irrespective of the person sought to be taxed. It is the recipient of the income that is taxed, not his property; and the vital question in each case is, Has the person sought to be taxed received an income during the tax year? If so, such income, unless specifically exempted, is subject to a tax though the property out of which it is paid may have been exempt from an income tax in the hands of the payor. It is the relation that exists between the person sought to be taxed and specific property claimed as income to him that determines whether there shall be a tax. If the person sought to be taxed is the recipient during the tax year of such specific property as income in its ordinary significance, then the person is taxed. But the tax is upon the right or ability to produce, create, receive, and enjoy, and not upon specific property. Hence the amount of the tax is measured by the amount of the income, irrespective of the amount of specific property or ability necessary to produce or create it. In the ordinary acceptation of the term this may be said to be a tax upon income as the statute denominates it. But the tax does not seek to reach property, or an interest in property as such. It is a burden laid upon the recipient of an income."'

2 In a case decided by the Supreme Judicial Court of Massachusetts, Suter v. Jordan-Marsh Company, 113 N. E. 580, it was held that the tax was levied upon the rent paid by the defendant to the plaintiff. See also Catawissa R. Co. v. Phila. & Reading Co., 255 Pa. St. 269, 99 Atl. 807.